EMU Accession Research Articles

Inflation and unemployment, new insights during the EMU accession

In the process of EU integration, toward the EA accession, we try to understand, how changes in exchange rate regime, attributed to the switch through the ERM-II and to the EA accession, influence the dynamic between inflation and unemployment, that is, swings on the Phillips curve coefficient. We look at a panel of EA countries, before and after their EA entry, over the last twenty years, using a recent work from McLeay and Tenreyro (2020) , to clarify the impact of losing the monetary autonomy. Accession to the Eurozone leads to a non-significant inflation/unemployment relationship. Accession to the Eurozone induces a non-significant inflation/unemployment relationship. We link this result to the fact that the small economies of the Eurozone do not have sufficient weight to influence the single monetary policy. This is corroborated by the fact that within the Eurozone, what we call the “economic leaders” maintain a significant trade-off between inflation and unemployment.

BULGARIA'S REAL CONVERGENCE IN THE CONTEXT OF POTENTIAL EMU MEMBERSHIP

Since the entry of Bulgaria into the European Union, the country's full membership in the Economic and Monetary Union has become one of the national economic policy goals. In the recent period Bulgaria fulfils all the nominal convergence criteria, except for the criterion on exchange rate stability as long as the country does not participate in the ERM II mechanism (although Bulgaria has a currency board arrangement in place since 1997 and the Bulgarian currency is pegged to the euro). Despite that, Bulgaria remains the EU member with the lowest level of GDP per capita and lowest productivity and income levels. In June 2018 the Bulgarian authorities submitted a letter of intent to the EU policy makers to join the ERM II mechanism and the banking union. In July 2020 the mutual agreement to include the Bulgarian lev in the ERM II mechanism and Bulgaria to join the banking union was achieved. In the context of the future full EMU membership it is important to assess the evolution and the state of Bulgaria's real convergence. This paper looks at the Bulgaria's real convergence, understood as the convergence of GDP per capita, labour productivity and convergence of price levels. We use the Beta and Sigma convergence methods and explore the convergence in the 1999-2018 period. We also compare Bulgaria's real convergence to the real convergence of other CEE countries that are EU members (Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia), part of which have already accepted the euro and the other part are still outside of the euroarea. We also try to explain the economic reasoning behind the EMU accession path of Bulgaria. The results of the survey show that Bulgaria lags behind in its convergence process from other CEE countries, but at the same time we believe that the benefits of the euroarea membership outweigh the possible negative consequences.

Risks of Global Financial Markets and the Importance of Credibility: Implications for Hungarian Fiscal Policy

The central issue in the controversy about the adoption of the euro in Hungary is the difficulties associated with the fulfillment of the fiscal criterion and the possible growth sacrifice it requires. In this paper the author examines the question whether the strategy of delaying entry into the euro-zone implies that fiscal consolidation can be delayed as well. In approaching the problem the paper considers the origins and history of the present-day global financial markets and argues that given the high degree of systemic risks individual countries face responsible macroeconomic policies are crucial in minimizing vulnerability tocrises. Consequently in order to avoid excessive interest rates and speculative inflows (or currency crisis in the worst case scenario) fiscal deficits in Hungary would have to be cut and credibility of fiscal policy reestablished even without EMU accession. The overall conclusion from this overview is that delaying entry in order to delay fiscal adjustment is likely to increase the trade off between real and nominal convergence instead of mitigating it.
 JEL classification: F33, F41, H62

Intrinsic vs. extrinsic incentives for reform: An informational mechanism of E(M)U conditionality

How does the prospect of accession to an international union affect a non-member-state government’s incentives to implement political and economic liberalization reforms? To answer this question, we propose an informational mechanism of international union accession conditionality drawing on Benabou and Tirole’s (The Review of Economic Studies, 70, 489–520, 2003) formalization of intrinsic and extrinsic motivation. In a Bayesian game of union accession between a supranational principal (e.g., EU Commission) and a national agent (e.g., the government of the target country), we find that the extrinsic bonus of post-accession transfers may on the one hand reinforce the agent’s short-term incentives to meet the accession criteria but on the other hand can also “crowd out” its intrinsic motivation to liberalize and comply with the union’s acquis in the long run. As a result, we expect that (i) net-recipient countries’ post-accession pace of reform may decline or even turn negative over time (temporal effect), (ii) the crowding-out effect will be stronger for countries that enjoy higher levels of distributive net transfers and those that go through a lengthier negotiation period (spatial effect), and (iii) early liberalizers are ex ante more likely to be officially selected as union candidate members, accept the accession contract, and implement the required reforms. We illustrate the theoretical mechanism and dynamics of the model with anecdotal evidence from two paired comparisons in respect to the effects of economic conditionality attached to EMU accession (Greece vs. Spain) and political conditionality attached to EU accession (Hungary vs. Estonia).

The Effects of Monetary Policy on House Prices in Spain: the role of the economic and monetary union membership in the housing bubble prior to the great recession

Aim: This paper aims to discover the evolution of monetary transmission in Spain by focusing on the short-term interest rate, credit aggregates and house prices through different stages of economic development and European integration between 1975 and 2008. In addition, the analysis devotes special attention to the interval of the last housing boom, in order to reveal the importance of the interest rate policy of the ECB.Design / Research methods: The study applies a tri-variate autoregressive model assigned to three overlapping periods outlined by regime shifts in the Spanish economy. The estimation output determines the strength and persistency of the links between interest rates, credit aggregates and house prices. Consequently, the results of the econometric analysis provide proper base for comparison in order to identify the dominating channels of monetary transmissions through a prolonged period.Conclusions / findings: It is found that the transmission mechanism in Spain essentially altered over time since 1975. At the beginning of the full analysed interval the role of the credit channel was dominant, then its importance gradually diminished. After the EMU accession the traditional interest rate channel became the leading factor with an intensified and more persistent effect on house prices.Originality / value of the article: While there are numerous researches aimed at estimating the impact of monetary policy on the real economy, empirical studies focusing exclusively on the link between interest rate policy and house prices in Spain are still rare. As the present paper concentrates solely on the Spanish characteristics through extended interval, the study provides country-specific inferences.Implications of the research: Understanding the mechanism of the monetary policy effects on the housing sector is an essential aspect of designing policy interventions aimed at keeping house price development in check.Limitations of the research: Despite the significant results of the empirical analysis, the excessively dynamic increase in the property prices suggests that the factor of irrational expectations also played important role in the latest Spanish housing bubble.Key words: Monetary policy, VAR, ECB, Housing boom, Monetary transmission mechanismJEL: E52, E58.

Exchange Rate Variability and Foreign Direct Investment – Consequences of EMU Enlargement

The aim of the paper is to analyze theoretically and empirically the likely impact of the reduction in exchange rate uncertainty, due to the EMU accession, on the intensity of FDI inflow into candidate countries. Theoretical models give an ambiguous picture of how exchange rate uncertainty and volatility affect direction and magnitude of FDI inflows. The main contribution of this paper is in finding that exchange rate uncertainty and volatility may negatively influence the decision to locate investment in transition and accession countries. Nominal exchange rate uncertainty seems to particularly hamper FDI inflows in accession countries. The key finding of this paper is that euro adoption is likely to exert a positive influence on FDI inflows in accession countries.

Greece and the Euro: The chronicle of an expected collapse

Ten years after Greece’s accession to EMU, the venture has proved to be almost a complete failure. Obviously, the country joined EMU disappointingly unprepared. After EMU accession, Greece failed to seek the necessary adaptations. Its economic policy was inconsistent with the economic logic and rules of the game of a monetary union. EMU did not in itself lead to the Greek crisis. Nevertheless, the supervisory arrangements clearly failed to work. Moreover, the unfolding of the crisis was assisted by EMU’s inherent weakness in managing asymmetric disturbances and the absence of early warning and rapid intervention mechanisms.

Nominal and Real Convergence in Alternative Exchange Rate Regimes in Transition Countries: Implications for the EMU Accession

This paper discusses the processes of nominal and real convergence and their dependence on exchange rate regimes adopted in Central and Eastern European countries (CEECs) in the context of their future EMU accession. We focus our argument on the possibility of trade-off between the pace of disinflation and the maintenance of competitiveness and growth. Fixed nominal exchange rate shifts the burden of adjustment on to the tradable sector but whether this pressure results in faster restructuring and faster productivity growth or becomes a straightjacket for the economy is an open question. The paper implements a simple empirical assessment of convergence of inflation to EU levels and economic growth of 7 CEE economies which had adopted different exchange rate regimes in period 1993-2002. Results indicate that fixed exchange rates seem to have been a better tool of fighting inflation as compared to floating exchange rates or intermediate regimes. The presence of a fixed exchange rate has also been characterised by higher real GDP growth rates implying an absence of trade-off between nominal and real convergence in the investigated sample. Qualifications attached to these results are discussed.

Alternative monetary policies and fiscal regime in new EU members

I investigate the relevance of a fiscal regime for disinflation in new EU member states (NMS). I generalize the framework of [Obstfeld, M., Rogoff, K., 1995. Exchange rate dynamics redux. Journal of Political Economy 103, 624–660] to incorporate the non-Ricardian fiscal regime and two monetary feedback rules: inflation targeting and depreciation targeting. Euro accession requires disinflation and stabilization of the exchange rate and thus restrictive monetary policy. The model illustrates that a sustainable and prudent fiscal policy is a necessary condition for successful stabilization of inflation. Thus, the lack of prudent fiscal policy, through its effects on inflation, may undermine the EMU accession of large NMS even when their fiscal outcomes fall within the Maastricht range.

Estimating the Degree of Interventionist Policies in the Run-Up to EMU

Based on a theoretical monetary exchange-rate model in continuous time this paper establishes a sequential estimation framework which is capable of indicating central bank intervention in the run-up to a currency union. Using daily pre-EMU exchange-rate data for the countries of the current euro zone, we find mixed evidence of active pre-EMU intervention policies (so-called institutional frontloading strategies). Our estimation framework is highly relevant to economic and political agents operating in financial markets of the upcoming EMU accession countries.

Estimating the degree of interventionist policies in the run-up to EMU

Based on a theoretical monetary exchange-rate model in continuous time, this article establishes a sequential estimation framework which is capable of indicating central bank intervention in the run-up to a currency union. Using daily pre-European Monetary Union (pre-EMU) exchange-rate data for the countries of the current Euro zone, we find mixed evidence of active pre-EMU intervention policies (so-called institutional frontloading strategies). Our estimation framework is highly relevant to economic and political agents operating in financial markets of the upcoming EMU accession countries.

Uncovered interest rate parity and analysis of monetary convergence of potential EMU accession countries

This paper analyzes deviations from uncovered interest rate parity which are interpreted as indicator of the substitutability of currencies. Backward recursive statistical tests and error correction models are applied to study the co-movement of interest rates, and rolling regressions are used to study size and volatility of country specific risk premiums. In accordance to their degree of monetary integration with the Euro area, new EU members and accession countries are divided into three groups. Estonia and Lithuania seem to exhibit the highest degree of monetary integration with the Euro area.

A Strategy for EMU Enlargement

This paper summarizes the results of CASE's research project on 'Strategies for Joining the EMU' and proposes policy recommendations both for new member states (on how to manage their accession to the Eurozone) and for the European Commission, ECB and old member states (on how to manage and absorb EMU enlargement in an optimal way). Both the economic and the political economy arguments point to fast EMU accession of NMS. Looking at the 'classical' optimum currency area criteria, i.e. trade integration, co-movement of business cycles and actual factor mobility, NMS' record is not worse, on average, than that of the current Eurozone members, and should further improve before Eurozone entry, decreasing risk of their exposure to idiosyncratic shocks. After joining the EMU, the common currency should help NMS to develop additional intra-EMU trade links, further synchronize business cycle and increase factor mobility. Both theoretical arguments and empirical experience demonstrates that so-called real convergence accompanies nominal convergence, and that there is synergy rather than a trade-off between the two. The credibility of the Euro and price stability in the Eurozone will not be threatened by fast EMU Enlargement. Neither can the accession of fast growing NMS create an additional 'recessionary' impact on slow growing incumbent members. The biggest challenge for the common currency in the medium to long run may come from widespread breaches of EU fiscal rules. So the incumbents should replace their 'don't rush' advice by active encouragement of NMS to proceed with fast nominal convergence in order to meet the Maastricht criteria and join the EMU as quickly as possible.

A Strategy for EMU Enlargement

This paper summarizes the results of CASE's research project on 'Strategies for Joining the EMU' and proposes policy recommendations both for new member states (on how to manage their accession to the Eurozone) and for the European Commission, ECB and old member states (on how to manage and absorb EMU enlargement in an optimal way). Both the economic and the political economy arguments point to fast EMU accession of NMS. Looking at the 'classical' optimum currency area criteria, i.e. trade integration, co-movement of business cycles and actual factor mobility, NMS' record is not worse, on average, than that of the current Eurozone members, and should further improve before Eurozone entry, decreasing risk of their exposure to idiosyncratic shocks. After joining the EMU, the common currency should help NMS to develop additional intra-EMU trade links, further synchronize business cycle and increase factor mobility. Both theoretical arguments and empirical experience demonstrates that so-called real convergence accompanies nominal convergence, and that there is synergy rather than a trade-off between the two. The credibility of the Euro and price stability in the Eurozone will not be threatened by fast EMU Enlargement. Neither can the accession of fast growing NMS create an additional 'recessionary' impact on slow growing incumbent members. The biggest challenge for the common currency in the medium to long run may come from widespread breaches of EU fiscal rules. So the incumbents should replace their 'don't rush' advice by active encouragement of NMS to proceed with fast nominal convergence in order to meet the Maastricht criteria and join the EMU as quickly as possible.

Fiscal Costs of Delaying the EMU Accession - Medium Term Fiscal Projection for Selected New EU Members

The paper presents series of medium term economic simulations, evaluating fiscal costs of different EMU entry scenarios for six of the new EU members. Projections cover period of 2004- 2012 and use basic macroeconomic equations in an attempt to assess the value of public debtrelated costs that may occur in each of the countries, under specific assumptions. Four series of simulations were run, assuming two different EMU entry dates (2007 and 2012), and two growth scenarios (2% and 5% of real GDP growth p.a.). For each growth variant the early and late accession projections are compared in order to evaluate the net fiscal effect of delaying the EMU entry. Those effects depend on country’s starting position and are quite significant for most of the countries in question. Poland and Hungary are the biggest winners of the earlier EMU entry simulations, both saving equivalence of 18-20% of their 2004 GDP levels (as compared to results of the late accession scenarios). It appears that the GDP growth rate does not seriously affect the volume of the gains, which are rather generated by the faster interest rate reduction and tighter fiscal policies in case of the earlier EMU accession.

Costs and Benefits of Poland's EMU Accession: a Tentative Assessment

This paper addresses the balance of costs and benefits arising from the adoption of the euro in Poland. It shows that given the present degree of economic integration between Poland and the euro area, the potential costs of relinquishing the monetary policy autonomy in Poland are likely to be modest. A tentative assessment suggests that the switch to the euro is expected to raise GDP per capita in Poland by 4%–7% in the long run. The paper concludes that, on balance, Poland is likely to benefit significantly from the EMU membership.

EMU Accession Issues in Estonia

The debate surrounding EMU enlargement is usually focused on the policy choices prior to EU accession, on Maastricht criteria and ERM-II, and on the existence of an optimum currency area between accession counties and the Euro Area. This paper reviews these issues from Estonia's perspective. Considering the small size of the Estonian economy, its currency-board-based monetary system and its openness towards the European Union, entrance into the EMU is a natural development. Caveats remain, but whether these caveats will be solved by a prolonged stay in ERM-II is a different matter.

New Member States' Trading Potential Following EMU Accession: A Gravity Approach

The purpose of this paper is to look at implications of the EMU accession on international trade flows of the new member states with members of the enlarged EU. I begin with the evaluation of an early impact of the EMU on trade based on a gravity model. The results are then employed in the calculation of potential levels of trade of the Central and East European countries. The results show a high degree of trade integration between most of the new member states and the EU except for Latvia, Lithuania and Poland. In trade among the new member states, potential trade flows by far exceed actual levels for all countries except the Czech Republic and Slovakia.

Exchange Rate Regimes and the Nominal Convergence

The paper examines theoretical literature, recent EMU accession examples, and current CEECs performance in search of the optimal currency regime for meeting the Maastricht criteria. Currency board arrangements seems to provide the fastest convergence. For other regimes, the markets may have theoretical and historical reasons to believe in the government's temptation to devalue on the ERM-2 entry. The government should announce the final date, and, possibly indicate the final exchange rate for the regime switch to avoid excessive currency and yield volatility. It should also underscore the central bank’s and EU authorities importance (even if non-existent) in the parity setting process to avoid excessive domestic debt inflation premium ahead of the accession. Recent experience shows that it will be easy to get rid of the remaining influence of cross rates on CEECs exchange rates.

When Should the Central Europeans Join EMU?

The paper first considers why central European countries wish to join EMU soon. The main reasons are the risk of macroeconomic instability they face outside the euro zone if they wish to grow quickly. At the same time, Central Europe is highly integrated as regards trade with EMU, so it is little exposed to asymmetric shocks that would require a realignment of exchange rates. Finally, it is argued that there is no cost in terms of slower growth from EMU accession, so that there is no trade-off, as has been claimed, between nominal convergence to EMU and real convergence to EU average GDP levels. Second, the paper assesses whether Central European accession to EMU would be disadvantageous to current members. It concludes that accession cannot increase inflationary pressure on existing EMU members, as has been claimed, but that slow growing members of EMU might suffer increased unemployment, unless they increase the flexibility of their labour markets. Incumbent members may also be unwilling to share power with Central Europeans in EMU institutions.